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Tax free settlement of family assets: How Godrej like family arrangement can help in redistribution of wealth among members without capital gain tax



The Supreme Court of India has stated that if a family divides its wealth among its members through a family arrangement following specific conditions, then the individual family members won’t have to pay capital gains tax. The Godrej family, worth billions of dollars, recently used this method to distribute its wealth, which included properties in prime locations and shares of its listed companies, among its family members.

“In the case of Godrej, specifically in the case of listed entities in the Group, there has been a realignment of shareholding amongst and within the promoter group in terms of the mutually agreed ‘Settlement Agreement’. What differentiates the Godrej split is that the family arrangement has been done keeping in mind the aspirations of the third and fourth generation of the family,” says Vishwas Panjiar, Partner, Nangia Andersen LLP.

What is the concept of ‘family arrangement’?

Family arrangement is an agreement that helps a family distribute its wealth among its members in a manner that avoids disputes or potential disputes.

“The Supreme Court of India has defined ‘family arrangement’ as an agreement between members of the same family, intended to be generally and reasonably for the benefit of the family either by compromising doubtful or disputed rights or by preserving the family property or the peace and security of the family by avoiding litigation or by saving its honour,” says Subham Chatterjee, Principal Associate, ALMT Legal Advocates and Solicitors.

Family arrangement: Which type of assets is exempted from tax

According to Panjiar, all types of capital assets like shares, investments, land etc., would be eligible for the exemption. “However, if the family partition also involves transfer of immovable properties, stamp duty implications may apply,” he says. This means that if you have the family wealth in the form of land, buildings, investments or other capital assets, you can distribute them all among the family members using the ‘family arrangement process’.

When is the ‘family arrangement’ process exempt from income tax?

Tax experts say that the concept of ‘family arrangement’ is not specially defined in the Income-tax Act, 1961. “Taxability arising from a family settlement emanates from judicial precedents that have been rendered by Courts over the years. It has been held that capital gain tax would not apply in case of transfer of assets pursuant to a family arrangement that meets the principles and established criterion,” says Panjiar.

Only in this case re-distribution of assets through family settlement will become taxable

As per a precedent set by the Bombay High Court, if the family settlement results in transfer of the family’s capital assets to a corporate entity, then it will become taxable. “The Bombay High Court observed that while the divestment of shares in a company by one family member in favour of another member pursuant to a family arrangement is not considered transfer and capital gains tax is not attracted, the same benefit is not extended to corporate entities. Therefore, transfer of shares by corporate entities including a body corporate would be deemed transfer under section 2(47) of the Income Tax Act, 1961 and capital gains tax will be attracted even if the said transfer is pursuant to a family arrangement,” says Chatterjee from ALMT Legal.

Criteria to be followed in ‘family arrangement’ so that it becomes tax-free

Legal experts say that the Supreme Court of India, in a 1976 case, set out criteria for a family arrangement to become legally binding and ultimately exempt from income tax. Panjiar from Nangia Andersen LLP shares the criteria:

  • The family settlement must be a bona fide one to resolve family disputes and rival claims by a fair and equitable division or allotment of properties between the various members of the family;
  • The said settlement must be voluntary and should not be induced by fraud, coercion or undue influence;
  • The family arrangement may even be oral, in which case no registration is necessary;
  • The members who may be parties to the family arrangement must have some ‘antecedent title’, claim or interest even a possible claim in the property acknowledged by the parties to the settlement.
  • Even if bona fide disputes, present or possible, which may not involve legal claims, are settled by a bona fide family arrangement which is fair and equitable, the family arrangement is final and binding on the parties to the settlement.

Even if a member of the family has no title over any asset being re-distributed under the family arrangement process, there exists certain legal caveats to benefit such a member.

Says Panjiar, “Even if one of the parties to the settlement has no title but under the arrangement the other party relinquishes all its claims or titles in favour of such a person and acknowledges him to be the sole owner, then the ‘antecedent title’ must be assumed and the family arrangement will be upheld and the Courts will find no difficulty in giving assent to the same.”

When does registration of the family settlement become necessary?

Experts say that the family settlement arrangement can be written in two ways — in a document which contains the terms and recitals of the family arrangement or a simple memorandum which is prepared after the family settlement arrangement had been already made for any purpose whatsoever.

As per Panjiar, the registration of the family settlement arrangement document is necessary only if the terms and recitals of the family arrangement are made in writing.

“In such a case the memorandum itself does not create or extinguish any rights in immovable properties and therefore does not fall within the mischief of section 17(2) of the Registration Act and is, therefore, not compulsorily registrable,” says Panjiar.

How can you set up a family arrangement process to re-distribute wealth among the family members?

Experts say that the family arrangement process usually begins with the family leader deciding redistribution of wealth after taking inputs from the family members.

“The family leader often plays a significant role in not only setting the tone of the discussion. Typically, family arrangement begins with a simple question: Is it going to be family first or should the family adopt a business first approach? Once this is decided, the next step is generally to have an open communication with the family members to understand their aspirations. Once family arrangement has been agreed upon, it is advisable to document the understanding through a formal agreement to reduce the chances of conflict amongst family members,” says Panjiar.

Family arrangements can also be made by setting up a family trust, although experts say that trust structures are mostly used for succession planning rather than for family settlement.

“Family arrangement can be set-up by way of an agreement between the family members whereas setting up of a family trust and transferring family properties (including immovable, movable assets, shares, receivables etc.) into the trust for the benefit of other members of the family (including minors), who are named as beneficiaries, is one of the other ways of managing and preserving family wealth for the benefit of the family members,” says Chatterjee.



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